SM Energy Company — Form 10-Q Summary
Business context and period. SM Energy is an independent onshore oil and gas producer focused on oil- and liquids-rich resource plays, including the Eagle Ford and Bakken/Three Forks. This unaudited filing covers the quarter and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods unless noted.
Financial and operating results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Oil, gas and NGL production revenue | $325.2 million | $197.4 million | $935.5 million | $586.1 million |
| Total operating revenues and other income | $530.6 million | $226.9 million | $1,223.8 million | $798.7 million |
| Net income | $230.1 million | $15.5 million | $336.1 million | $159.7 million |
| Diluted earnings per share | $3.41 | $0.24 | $4.99 | $2.47 |
| Net cash provided by operating activities | Not stated for quarter | Not stated for quarter | $489.7 million | $418.4 million |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $1,081.6 million | $488.7 million |
- Q3 average production reached a record 462.1 million cubic feet equivalent per day, up 55%; nine-month average production was 433.7 million cubic feet equivalent per day, up 51%.
- Q3 realized oil price was $82.63 per barrel, natural gas $4.52 per Mcf, and NGLs $56.10 per barrel, before derivative settlements. Nine-month oil and gas prices were $88.54 per barrel and $4.51 per Mcf; NGLs were $52.71 per barrel.
- Q3 production expense was $77.8 million, up 74%, with higher transportation costs in the growing Eagle Ford program. Per-unit production costs were $1.83 per Mcfe for the quarter; nine-month costs were $1.66 per Mcfe.
- Operating results included a $190.7 million Q3 divestiture gain and a $48.5 million impairment of legacy James Lime properties, attributed primarily to depressed gas prices. Nine-month divestiture gains totaled $245.7 million. Derivative fair-value changes produced a $128.4 million Q3 gain and an $83.9 million nine-month gain; these are not equivalent to cash generation.
- Nine-month investing cash outflow was $756.9 million, including the $1,081.6 million of capital expenditures and $325.1 million of net property-sale proceeds. Financing cash inflow was $292.0 million. Cash rose to $29.9 million from $5.1 million at year-end 2010.
Balance sheet, debt and liquidity
- At September 30, 2011, cash was $29.9 million; current assets were $304.7 million and current liabilities $423.5 million.
- Long-term debt carrying value totaled approximately $632.6 million: $282.6 million of 3.50% senior convertible notes and $350.0 million of 6.625% senior notes. The revolving credit facility was undrawn; $999.4 million of borrowing capacity was available. The borrowing base was $1.4 billion, against $1.0 billion of lender commitments.
- The company issued $350.0 million of 6.625% notes in February 2011, using proceeds in part to repay credit-facility borrowings. The new notes mature in 2019. The convertible notes have a 2012 holder put date; holders may require repurchase of all or part, subject to the company’s settlement options.
- Management reported compliance with debt covenants. Credit-agreement debt-to-EBITDAX and current ratios were 0.79 and 3.10, respectively, as defined by that agreement.
Changes, outlook and material considerations
- Revenue and earnings growth reflected sharply higher production, stronger oil pricing, a $190.7 million Q3 Eagle Ford asset-sale gain, and derivative fair-value gains. Divestiture gains and derivative marks are significant and may not recur.
- Management planned four operated Eagle Ford rigs at quarter-end and expected two additional walking rigs by the end of Q1 2012. It expected three to four rigs in the Williston Basin during 2012, one Haynesville rig through Q3 2012 to hold acreage by production, and two Granite Wash rigs for the remainder of 2011. No specific earnings or production guidance was provided.
- Management expected operating cash flow, divestiture proceeds and/or joint-venture activity to fund most of the remaining 2011 capital program, with the undrawn credit facility available for any shortfall. It stated that liquidity was adequate for planned activities.
- A proposed Mitsui transaction would transfer a 12.5% working interest in approximately 39,000 non-operated Eagle Ford acres in exchange, in part, for a carry of up to $680 million of drilling and completion costs. The closing deadline was extended to December 23, 2011, and completion was uncertain. The separate $80 million Marcellus sale was also subject to closing conditions and remained uncertain.
- Two natural-gas gathering agreements carry up to ten-year throughput commitments; if no gas were delivered, aggregate deficiency payments could total approximately $726.2 million. A hydraulic-fracturing services contract had $112.5 million remaining; termination without cause could cost up to $24.0 million.
- In an Eagle Ford royalty dispute, a court entered a $5.1 million judgment against defendants; SM Energy intended to appeal and had not accrued a loss, stating an unfavorable outcome was not considered probable. Arbitration with Anadarko could result in an interest of up to 8.333% in certain acreage or damages; the decision was pending. A separate arbitration over consents needed for the Mitsui deal was underway.
- Key risks include commodity-price volatility, transportation and takeaway capacity, drilling and water availability, potential hydraulic-fracturing and emissions regulation, tax-law changes, reserve replacement, and the uncertain completion of planned sales and joint ventures. Management noted transportation costs per Mcfe were expected to rise as Eagle Ford production grew.
Important facts for investors to verify
- How much reported earnings depended on asset-sale gains, noncash derivative gains and the Net Profits Plan liability remeasurement, versus recurring operations and cash flows.
- Whether the Mitsui transaction and Marcellus sale closed, and the final proceeds, adjustments and resulting capital commitments.
- Actual capital spending, production growth, per-unit transportation costs, and cash flow relative to management’s plans.
- Commodity-hedge volumes, terms and settlements, and the effect of hedge accounting discontinuation on reported earnings volatility.
- Developments in the gathering commitments, royalty litigation and arbitrations, and any resulting payments or changes to working interests.
- The timing and funding consequences of the convertible-note holder put in April 2012 and the company’s ongoing liquidity and covenant position.